Joseph Schumpeter

Economic Development and Entrepreneurship




These are passages from Chapter II of The Theory of Economic Development. For Schumpeter economic development is the result of finding and implementing new fruitful economic combinations amongst the means of production. This is the task and the role of the entrepreneur, and for this reason, there cannot be economic development without the rise of entrepreneurship and the presence of conditions that make entrepreneurship possible.



Economic history

Economic development is so far simply the object of economic history, which in turn is merely a part of universal history, only separated from the rest for purposes of exposition. Because of this fundamental dependence of the economic aspect of things on everything else, it is not possible to explain economic change by previous economic conditions alone. For the economic state of a people does not emerge simply from the preceding economic conditions, but only from the preceding total situation. The expository and analytical difficulties which arise from this are very much diminished, practically if not in principle, by the facts which form the basis of economic interpretation of history; without being compelled to take a stand for or against this view, we can state that the economic world is relatively autonomous because it takes up such a great part of a nation's life, and forms or conditions a great part of the remainder; wherefore writing economic history by itself is obviously a different thing from writing, say, military history.

To this must be added still another fact which facilitates the separate description of any of the divisions of the social process. Every sector of social life is, as it were, inhabited by a distinct set of people. The heteronomous elements generally do not affect  the social process in any such sector directly as the bursting of a bomb “affects” all things which happen to be in the room in which it explodes, but only through its data and the conduct of its inhabitants; and even if an event occurs like the one suggested by our metaphor of a bursting bomb, the effects only occur in the particular garb with which those primarily concerned dress them. Therefore, just as describing the effects of the Counter Reformation upon Italian and Spanish painting always remains history of art, so describing the economic process remains economic history even where the true causation is largely non-economic.


Economic development

By "development," [therefore], we shall understand only such changes in economic life as are not forced upon it from without but arise by its own initiative, from within. Should it turn out that there are no such changes arising in the economic sphere itself, and that the phenomenon that we call economic development is in practice simply founded upon the fact that the data change and that the economy continuously adapts itself to them, then we should say that there is no economic development. By this we should mean that economic development is not a phenomenon to be explained economically, but that the economy, in itself without development, is dragged along by the changes in the surrounding world, that the causes and hence the explanation of the development must be sought outside the group of facts which are described by economic theory.
Nor will the mere growth of the economy, as shown by the growth of population and wealth, be designated here as a process of development. For it calls forth no qualitatively new phenomena, but only processes of adaptation of the same kind as the changes in the natural data. Since we wish to direct our attention to other phenomena, we shall regard such increases as changes in data.

Every concrete process of development finally rests upon preceding development. But in order to see the essence of the thing dearly, we shall abstract from this and allow the development to arise out of a position without development. Every process of development creates the prerequisites for the following. Thereby the form of the latter is altered, and things will turn out differently from what they would have been if every concrete phase of development had been compelled first to create its own conditions. However, if we wish to get at the root of the matter, we may not include in the data of our explanation elements of what is to be explained. But if we do not do this, we shall create an apparent discrepancy between fact and theory, which may constitute an important difficulty for the reader.


The producer

These spontaneous and discontinuous changes in the channel of the circular flow and these disturbances of the centre of equilibrium appear in the sphere of industrial and commercial life, not in the sphere of the wants of the consumers of final products. Where spontaneous and discontinuous changes in consumers’ tastes appear, it is a question of a sudden change in data with which the businessman must cope, hence possibly a question of a motive or an opportunity for other than gradual adaptations of his conduct, but not of such other conduct itself. Therefore this case does not offer any other problems than a change in natural data or require any new method of treatment; wherefore we shall neglect any spontaneity of consumers' needs that may actually exist, and assume tastes as “given.” This is made easy for us by the fact that the spontaneity of wants is in general small. To be sure, we must always start from the satisfaction of wants, since they are the end of all production, and the given economic situation at any time must be understood from this aspect. Yet innovations in the economic system do not as a rule take place in such a way that first new wants arise spontaneously in consumers and then the productive apparatus swings round through their pressure. We do not deny the presence of this nexus. It is, however, the producer who as a rule initiates economic change, and consumers are educated by him if necessary; they are, as it were, taught to want new things, or things which differ in some respect or other from those which they have been in the habit of using. Therefore, while it is permissible and even necessary to consider consumers' wants as an independent and indeed the fundamental force in a theory of the circular flow, we must take a different attitude as soon as we analyse change.


Development as production of new combinations

To produce means to combine materials and forces within our reach. To produce other things, or the same things by a different method, means to combine these materials and forces differently. In so far as the “new combination” may in time grow out of the old by continuous adjustment in small steps, there is certainly change, possibly growth, but neither a new phenomenon nor development in our sense. In so far as this is not the case, and the new combinations appear discontinuously, then the phenomenon characterising development emerges. For reasons of expository convenience, henceforth, we shall only mean the latter case when we speak of new combinations of productive means. Development in our sense is then defined by the carrying out of new combinations.

This concept covers the following five cases: (1) The introduction of a new good - that is one with which consumers are not yet familiar - or of a new quality of a good. (2) The introduction of a new method of production, that is one not yet tested by experience in the branch of manufacture concerned, which need by no means be founded upon a discovery scientifically new, and can also exist in a new way of handling a commodity commercially. (3) The opening of a new market, that is a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before. (4) The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has first to be created. (5) The carrying out of the new organisation of any industry, like the creation of a monopoly position (for example through trustification) or the breaking up of a monopoly position.


Development as discontinuity

Now two things are essential for the phenomena incident to the carrying out of such new combinations, and for the understanding of the problems involved. In the first place it is not essential to the matter - though it may happen - that the new combinations should be carried out by the same people who control the productive or commercial process which is to be displaced by the new. On the contrary, new combinations are, as a rule, embodied, as it were, in new firms which generally do not arise out of the old ones but start producing beside them; to keep to the example already chosen, in general it is not the owner of stage-coaches who builds railways. This fact not only puts the discontinuity which characterises the process we want to describe in a special light, and creates so to speak still another kind of discontinuity in addition to the one mentioned above, but it also explains important features of the course of events. Especially in a competitive economy, in which new combinations mean the competitive elimination of the old, it explains on the one hand the process by which individuals and families rise and fall economically and socially and which is peculiar to this form of organisation, as well as a whole series of other phenomena of the business cycle, of the mechanism of the formation of private fortunes, and so on.


The procurement of the means of production

The next step in our argument is also self-evident: command  over means of production is necessary to the carrying out of new combinations. Procuring the means of production is one distinct problem for the established firms which work within the circular flow. For they have them already procured or else can procure currently with the proceeds of previous production. There is no fundamental gap here between receipts and disbursements, which, on the contrary, necessarily correspond to one another just as both correspond to the means of production offered and to the products demanded. Once set in motion, this mechanism works automatically. Furthermore, the problem does not exist in a non-exchange economy even if new combinations are carried out in it; for the directing organ, for example a socialist economic ministry, is in a position to direct the productive resources of the society to new uses exactly as can direct them to their previous employments. The new employment may, under certain circumstances, impose temporary sacrifices, privations, or increased efforts upon the members of the community; it may presuppose the solution of difficult problems, for example the question from which of the old combinations the necessary productive means should be withdrawn; but there is no question of procuring means of production not already at the disposal of the economic ministry. Finally, the problem also do not exist in a competitive economy in the case of the carrying of new combinations, if those who carry them out have the necessary productive means or can get them in exchange for others which they have or for any other property which they may possess. This is not the privilege of the possession of property per se, but only the privilege of the possession of disposable property that is such as is employable either immediately for carrying out the new combination or in exchange for the necessary goods and services. In the contrary case - and this is the rule as it is the fundamentally interesting case - the possessor of wealth, even if it is the greatest combine, must resort to credit if he wishes to carry out a new combination, which cannot like an established business be financed by returns from previous production.


The provision of credit

To provide this credit is clearly the function of that category of individuals which we call "capitalists." It is obvious that this is the characteristic method of the capitalist type of society - and important enough to serve as its differentia specifica - for forcing the economic system into new channels, for putting its means at the service of new ends, in contrast to the method of a non-exchange economy of the kind which simply consists in exercising the directing organ’s power to command.

It does not appear to me possible to dispute in any way the foregoing statement. Emphasis upon the significance of credit is to be found in every textbook. That the structure of modem industry could not have been erected without it, that it makes the individual to a certain extent independent of inherited possessions, that talent in economic life "rides to success on its debts," even the most conservative orthodoxy of the theorists cannot well deny. Nor is the connection established here between credit and the carrying out of innovations, a connection which will be worked out later, anything to take offence at. For it is as clear a priori as it is established historically that credit is primarily necessary to new combinations and that it is from these that it forces its way into the circular flow, on the one hand because it was originally necessary to the founding of what are now the old firms, on the other hand because its mechanism, once in existence, also seizes old combinations for obvious reasons. First, a priori: we saw that borrowing is not a necessary element of production in the normal circular flow within accustomed channels, is not an element without which we could not understand the essential phenomena of the latter. On the other hand, in carrying out new combinations, “financing” as a special act is fundamentally necessary, in practice as in theory. Second, historically: those who lend and borrow for industrial purposes do not appear early in history. The pre-capitalistic lender provided money for other than business purposes. And we all remember the type of industrialist who felt he was losing caste by borrowing and who therefore shunned banks and bills of exchange. The capitalistic credit system has grown out of and thrived on the financing of new combinations in all countries, even though in a different way in each (the origin of German joint stock banking is especially characteristic). Finally there can be no stumbling block in our speaking of receiving credit in “money or money substitutes.” We certainly do not assert that one can produce with coins, notes, or bank balances, and do not deny that services of labor, raw materials, and tools are the things wanted. We are only speaking of a method of procuring them.

Nevertheless there is a point here in which, as has already been hinted, our theory diverges from the traditional view. The accepted theory sees a problem in the existence of the productive means, which are needed for new, or indeed any, productive processes, and this accumulation therefore becomes a distinct function or service. We do not recognise this problem at all; it appears to us to be created by faulty analysis. It does not exist in the circular flow, because the running of the latter presupposes given quantities of means of production. But neither does it exist for the carrying out of new combinations, because the productive means required in the latter are drawn from the circular flow whether they already exist there in the shape wanted or have first to be produced by other means of production existing there. Instead of this problem another exists for us: the problem of detaching productive means (already employed somewhere) from the circular flow and allotting them to new combinations. This is done by credit, by means of which one who wishes to carry out new combinations outbids the producers in the circular flow in the market for the required means of production. And although the meaning and object of this process lies in a movement of goods from their old towards new employments, it cannot be described entirely in terms of goods without overlooking something essential, which happens in the sphere of money and credit and upon which depends the explanation of important phenomena in the capitalist form of economic organisation, in contrast to other types.


The banks as generators of credit

Finally one more step in this direction: whence come the sums needed to purchase the means of production necessary for the new combinations if the individual concerned does not happen to have them? The conventional answer is simple: out of the annual growth of social savings plus that part of resources which may annually become free. Now the first quantity was indeed important enough before the war - it may perhaps be estimated as one-fifth of total private incomes in Europe and North America - so that together with the latter sum, which it is difficult to obtain statistically, it does not immediately give the lie quantitatively to this answer. At the same time a figure representing the range of all the business operations involved in carrying out new combinations is also not available at present. But we may not even start from total “savings.” For its magnitude is explicable only by the results of previous development. By far the greater part of it does not come from thrift in the strict sense, that is from abstaining from the consumption of part of one's regular income, but it consists of funds which are themselves the result of successful innovation and in which we shall later recognise entrepreneurial profit. In the circular flow there would be on the one hand no such rich source, out of which to save, and on the other hand essentially less incentive to save. The only big incomes known to it would be monopoly revenues and the rents of large landowners; while provision for misfortunes and old age, perhaps also irrational motives, would be the only incentives. The most important incentive, the chance of participating in the gains of development, would be absent. Hence, in such an economic system there could be no great reservoirs of free purchasing power, to which one who wished to form new combinations could turn - and his own savings would only suffice in exceptional cases. All money would circulate, would be fixed in definite established channels.

Even though the conventional answer to our question is not obviously absurd, yet there is another method of obtaining money for this purpose, which claims our attention, because it, unlike the one referred to, does not presuppose the existence of accumulated results of previous development, and hence may be considered as the only one which is available in strict logic. This method of obtaining money is the creation of purchasing power by banks. The form it takes is immaterial. The issue of bank-notes not fully covered by specie withdrawn from circulation is an obvious instance, but methods of deposit banking render the same service, where they increase the sum total of possible expenditure. Or we may think of bank acceptances in so far as they serve as money to make payments in wholesale trade. It is always a question, not of transforming purchasing power which already exists in someone's possession, but of the creation of new purchasing power out of nothing - out of nothing even if the credit contract by which the new purchasing power is created is supported by securities which are not themselves circulating media - which is added to the existing circulation. And this is the source from which new combinations are often financed, and from which they would have to be financed always, if results of previous development did not actually exist at any moment.


The bankers as the capitalists par excellence

These credit means of payment, that is means of payment which are created for the purpose and by the act of giving credit, serve just as ready money in trade, partly directly, partly because they can be converted immediately into ready money for small payments or payments to the non-banking classes - in particular to wage-earners. With their help, those who carry out new combinations can gain access to the existing stocks of productive means, or, as the case may be, enable those from whom they buy productive services to gain immediate access to the market for consumption goods. There is never, in this nexus, granting of credit in the sense that someone must wait for the equivalent of his service in goods, and content himself with a claim, thereby fulfilling a special function; not even in the sense that someone has to accumulate means of maintenance for laborers or landowners, or produced means of production, all of which would only be paid for out of the final results of production. Economically, it is true, there is an essential difference between these means of payment, if they are created for new ends, and money or other means of payment of the circular flow. The latter may be conceived on the one hand as a kind of certificate for completed production and the increase in the social product effected through it, and on the other hand as a kind of order upon, or claim to, part of this social product. The former have not the first of these two characteristics. They too are orders, for which one can immediately procure consumption goods, but not certificates for previous production. Access to the national dividend is usually to be had only on condition of some productive service previously rendered or of some product previously sold. This condition is, in this case, not yet fulfilled. It will be fulfilled only after the successful completion of the new combinations. Hence this credit will in the meantime affect the price level.

The banker, therefore, is not so much primarily a middleman in the commodity “purchasing power” as a producer of this commodity. However, since all reserve funds and savings to-day usually flow to him, and the total demand for free purchasing power, whether existing or to be created, concentrates on him, he has either replaced private capitalists or become their agent; he has himself become the capitalist par excellence. He stands between those who wish to form new combinations and the possessors of productive means. He is essentially a phenomenon of development, though only when no central authority directs the social process. He makes possible the carrying out of new combinations, authorises people, in the name of society as it were, to form them. He is the ephor of the exchange economy.


The enterprise and the entrepreneur

We now come to the third of the elements with which our analysis works, namely the new combination of means of production and credit. Although all three elements form a whole, the third may be described as the fundamental phenomenon of development. The carrying out of new combinations we call “enterprise”; the individuals whose function it is to carry them out we call “entrepreneurs.” These concepts are at once broader and narrower than the usual. Broader, because in the first place we call entrepreneurs not only those “independent” business in an exchange economy who are usually so designated, but all who actually fulfil the function by which we define the concept, even if they are, as is becoming the rule, “dependent” employees of a company, like managers, members of boards of directors, and so forth, or even if their actual power to perform the entrepreneurial function has any other foundations, such as the control of a majority of shares. As it is the carrying out of new combinations that constitutes the entrepreneur, it is not necessary that he should be permanently connected with an individual firm; many “financiers,” “promotors,” and so forth are not, and still they may be entrepreneurs in our sense. On the other hand, our concept is narrower than the traditional one in that it does not include all heads of firms or managers or industrialists who merely may operate an established business, but only those who actually perform that function.

Nevertheless I maintain that the above definition does no more than formulate with greater precision what the traditional doctrine really means to convey. In the first place our definition agrees with the usual one on the fundamental point of distinguishing between “entrepreneurs” and “capitalists” - irrespective of whether the latter are regarded as owners of money, claims to money, or material goods. This distinction is common property to-day and has been so for a considerable time. It also settles the question whether the ordinary shareholder as such is an entrepreneur [Note: A shareholder may be an entrepreneur. He may even owe to his holding a controlling interest the power to act as an entrepreneur. Shareholders per se, however, are never entrepreneurs, but merely capitalists, who in consideration of their submitting to certain risks participate in profits], and disposes of the conception of the entrepreneur as risk bearer [Note: Risk obviously always falls on the owner of the means of production or of the money-capital which was paid for them, hence never on the entrepreneur as such]. Furthermore, the ordinary characterisation of the entrepreneur type by such expressions as “initiative,” “authority,” or “foresight” points entirely in our direction. For there is little scope for such qualities within the routine of the circular flow, and if this had been sharply separated from the occurrence of changes in this routine itself, the emphasis in the definition of the function of entrepreneurs would have been shifted automatically to the latter.

Finally there are definitions which we could simply accept. There is in particular the well known one that goes back to J. B. Say: the entrepreneur's function is to combine the productive factors, to bring them together. Since this is a performance of a special kind only when the factors are combined for the first time - while it is merely routine work if done in the course of running a business - this definition coincides with ours.


The distinction between capitalist and entrepreneur

In the general position of the chief of a primitive horde it is difficult to separate the entrepreneurial element from the others. For the same reason most economists up to the time of the younger Mill failed to keep capitalist and entrepreneur distinct because the manufacturer of a hundred years ago was both; and certainly the course of events since then has facilitated the making of this distinction, as the system of land tenure in England has facilitated the distinction between farmer and landowner, while on the Continent this distinction is still occasionally neglected, especially in the case of the peasant who tills his own soil. But in our case there are still more of such difficulties. The entrepreneur of earlier times was not only as a rule the capitalist too, he was also often - as he still is to-day in the case of small concerns - his own technical expert, in so far as a professional specialist was not called in for special cases. Likewise he was (and is) often his own buying and selling agent, the head of his office, his own personnel manager, and sometimes, even though as a rule he of course employed solicitors, his own legal adviser in current affairs. And it was performing some or all of these functions that regularly filled his days. The carrying out of new combinations can no more be a vocation than the making and execution of strategical decisions, although it is this function and not his routine work that characterises the military leader. Therefore the entrepreneur's essential function must always appear mixed up with other kinds of activity, which as a rule must be much more conspicuous than the essential one. Hence the Marshallian definition of the entrepreneur, which simply treats the entrepreneurial function as “management” in the widest meaning, will naturally appeal to most of us. We do not accept it, simply because it does not bring out what we consider to be the salient point and the only one which specifically distinguishes entrepreneurial from other activities.


Entrepreneurship is not a profession

[But whatever the type,] everyone is an entrepreneur only when he actually “carries out new combinations,” and loses that character as soon as he has built up his business, when he settles down to running it as other people run their businesses. This is the rule, of course, and hence it is just as rare for anyone always to remain an entrepreneur throughout the decades of his active life as it is for a businessman never to have a moment in which he is an entrepreneur, to however modest a degree.

Because being an entrepreneur is not a profession and as a rule not a lasting condition, entrepreneurs do not form a social class in the technical sense, as, for example, landowners or capitalists or workmen do. Of course the entrepreneurial function will lead to certain class positions for the successful entrepreneur and his family. It can also put its stamp on an epoch of social history, can form a style of life, or systems of moral and aesthetic values; but in itself it signifies a class position no more than it presupposes one. And the class position which may be attained is not as such an entrepreneurial position, but is characterised as landowning or capitalist, according to how the proceeds of the enterprise are used. Inheritance of the pecuniary result and of personal qualities may then both keep up this position for more than one generation and make further enterprise easier for descendants, but the function of the entrepreneur itself cannot be inherited, as is shown well enough by the history of manufacturing families.


The specific type of leadership of the entrepreneur

The entrepreneurial kind of leadership, as distinguished from other kinds of economic leadership such as we should expect to find in a primitive tribe or a communist society, is of course colored by the conditions peculiar to it. It has none of that glamour which characterises other kinds of leadership. It consists in fulfilling a very special task which only in rare cases appeals to the imagination of the public. For its success, keenness and vigor are not more essential than a certain narrowness which seizes the immediate chance and nothing else. “Personal weight” is, to be sure, not without importance. Yet the personality of the capitalistic entrepreneur need not, and generally does not, answer to the idea most of us have of what a “leader” looks like, so much so that there is some difficulty in realizing that he comes within the sociological category of leader at all. He “leads” the means of production into new channels. But this he does, not by convincing people of the desirability of carrying out his plan or by creating confidence in his leading in the manner of a political leader - the only man he has to convince or to impress is the banker who is to finance him - but by buying them or their services, and then using them as he sees fit. He also leads in the sense that he draws other producers in his branch after him. But as they are his competitors, who first reduce and then annihilate his profit, this is, as it were, leadership against one's own will. Finally, he renders a service, the full appreciation of which takes a specialist’s knowledge of the case. It is not so easily understood by the public at large as a politician's successful speech or a general’s victory in the field, not to insist on the fact that he seems to act - and often harshly - in his individual interest alone. We shall understand, therefore, that we do not observe, in this case, the emergence of all those affective values which are the glory of all other kinds of social leadership.


The motives of the entrepreneur

We shall finally try to round off our picture of the entrepreneur in the same manner in which we always, in science as well as in practical life, try to understand human behavior, viz. by analysing the characteristic motives of his conduct.

First of all, there is the dream and the will to found a private kingdom, usually, though not necessarily, also a dynasty. The modern world really does not know any such positions, but what may be attained by industrial or commercial success is still the nearest approach to medieval lordship possible to modern man. Its fascination is specially strong for people who have no other chance of achieving social distinction. The sensation of power and independence loses nothing by the fact that both are largely illusions. Closer analysis would lead to discovering an endless variety within this group of motives, from spiritual ambition down to mere snobbery. But this need not detain us. Let it suffice to point out that motives of this kind, although they stand nearest to consumers’ satisfaction, do not coincide with it.

Then there is the will to conquer: the impulse to fight, to prove oneself superior to others, to succeed for the sake, not of the fruits of success, but of success itself. From this aspect, economic action becomes akin to sport - there are financial races, or rather boxing-matches. The financial result is a secondary consideration, or, at all events, mainly valued as an index of success and as a symptom of victory, the displaying of which very often is more important as a motive of large expenditure than the wish for the consumers’ goods themselves. Again we should find countless nuances, some of which, like social ambition, shade into the first group of motives. And again we are faced with a motivation characteristically different from that of “satisfaction of wants” in the sense defined above, or from, to put the same thing into other words, “hedonistic adaptation.”

Finally, there is the joy of creating, of getting things done, or simply of exercising one’s energy and ingenuity. This is akin to a ubiquitous motive, but nowhere else does it stand out as an independent factor of behavior with anything like the clearness with which it obtrudes itself in our case. Our type seeks out difficulties, changes in order to change, delights in ventures. This group of motives is the most distinctly anti-hedonist of the three.

Only with the first groups of motives is private property as the result of entrepreneurial activity an essential factor in making it operative. With the other two it is not. Pecuniary gain is indeed a very accurate expression of success, especially of relative success, and from the standpoint of the man who strives for it, it has the additional advantage of being an objective fact and largely independent of the opinion of others. These and other peculiarities incident to the mechanism of “acquisitive” society make it very difficult to replace it as a motor of industrial development, even if we would discard the importance it has for creating a fund ready for investment. Nevertheless it is true that the second and third groups of entrepreneurial motives may in principle be taken care of by other social arrangements not involving private gain from economic innovation.



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